Streaming music pioneer Pandora's (P) shares are up 14 cents, or 3.5%, at $4.46, after the Copyright Royalty Board, the body set up by the Library of Congress to establish licenses for using copyrighted works, over the weekend hiked rates for what Pandora must pay to stream music.

Evercore ISI’s Anthony DiClemente, who has an “In Line” rating on Pandora shares, thinks this makes it more important than ever for Pandora to “scale” its platform to “grow their leverage and control costs.”

As DiClemente describes it, the rate change has a gradual impact on what Pandora pays, with payments to record labels being the bigger issue:

The new royalty structure calls not for a large immediate step-up, but rather for a gradual increase from the current 10.5% of a platform's on demand streaming revenue to an 11.4% rate in 2018 and to an ultimate rate of 15.1% by 2022. Please recall that royalties paid to publishers/songwriters come in addition to those paid to record labels, and the payments to the labels represent a large majority of streaming music content costs.

He sees a bigger impact to Spotify:

The impact to Spotify here is relatively more meaningful. Based on most recently publicly available data, which revealed Spotify generated revenue of $2.26bn in 1H17, the 90bps rate increase in songwriter royalties would increase costs by more than $40mn on a full year run-rate basis. While we do not have projections for Spotify 2022 revenue, the incremental impact of this rate step-up could exceed $100mn at that point. Of course, these increases could be offset by improving economics for royalty rates paid by Spotify to the record labels, which were recently restruck.

B. Riley FBN’s Barton Crockett, who has a Neutral rating on Pandora stock, thinks this makes a purchase by Sirius or Liberty less likely.,

He thinks the advertising business now becomes more “strategic” than the subscription business.

Pandora is stating that the 2018 fee is consistent with a step up that Pandora had already been assuming internally for this year. But, we believe the fee levels in later periods are probably bigger than what Pandora was anticipating. Pandora has not yet specifically guided for 2018 earnings and beyond, so we don't really know what Pandora was thinking for 2018. We are modeling a subscription gross profit of $100 million in 2017 (a 33.3% gross margin) and $150 million in 2018 (32.5% gross margin). We keep the gross margin going forward near 33%. We allocate opex and have subscription EBITDA negative in 2017, and breaking into positive territory in 2020. All else being equal, this decision would seem to argue that we will need to take down our forward gross margin assumption in subscription in direct proportion to the higher songwriter fees. But we know that Pandora CEO Roger Lynch has said that he wants to work with labels to obtain more flexibility in its performance rights in ways that could, for instance, allow Pandora to better compete with Spotify's discounted plans targeting college students and families. As part of that, we suppose it is possible that Pandora could seek some relief from labels to offset the higher songwriter fees. Labels have seen streaming as a key growth area, and might be willing to make some concessions to protect the viability of this area.

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